Markets: Fixed Income
On Thursday, global bonds traded mostly sideways little moved by the ECB and BoE meetings, before a selling wave pushed bonds sharply lower following a tepid US 30-year bond auction. Strength in equities once more had only a very limited impact. In a daily perspective, the US curve steepened bearishly with 2-year yields up 2.4 and 30-year yields up 8.6 basis points. The move came after the closure of the EMU markets leaving German bonds across the curve virtually unchanged.
Intra-day, the Bund opened little changed and kept hovering in a very tight range until the US claims were released and ECB Trichet gave his press conference. The French Business confidence survey and German production data were near expectations and thus ignored. US claims tumbled unexpectedly. US Treasuries dipped lower, but without follow through selling the market concluded that sentiment was positive and Treasuries (and Bunds) ticked higher. However, the move lacked conviction and bonds stabilized. ECB Trichet was very happy to convey an almost identical message as the one conveyed in September (see below). So, markets were nearly unmoved. That remained basically the case until the results of the US 30-year bond auction were published, showing a tepid reception of the issue. Following a series of highly successful auctions, that was enough to generate a selling move that pushed bonds quite a bit lower. However, the bullish longer term technical pictures remained unchanged.
Intra-EMU government yield spreads versus Germany stabilized.
US 30-year bond auction triggers correction
Today, the market calendar is very thin with few market moving items. Indeed, the US August trade balance (August) and the French and Italian industrial production (August) are the only eco data of importance. Besides these there are speeches of ECB president Trichet and Fed vice-chairman Kohn. However, Trichet spoke as recently as yesterday and also Kohn unveiled his thoughts recently. Therefore, we don’t expect them to have an impact on trading.
The US trade balance has improved considerably since about one year on the back of the recession and a steep drop in the price of oil and other commodity prices. However, in the past few months the improvement stalled and the market expects again a slightly bigger deficit in August. Indeed, oil prices have again gone up and the economy is on a stronger footing. French and Italian production data are expected to show solid gains in August, similar to the situation in Germany that reported a strong rise yesterday. If confirmed, it would signal that EMU production is up in August and mark the turnaround in production in the euro area.
Yesterday evening, the US 30-year re-opening (08/2039) didn’t go very well, but wasn’t a complete failure either. However, on the back of some very strong auctions in recent months it was a disappointment. Indeed, the auction stopped at 4.009%, well above the 3.979% bid in the WI at the moment of the stop. The bid/cover of 2.37 was close to average, but Indirect bidders took down only 34.5% of the auction, the lightest in recent auctions. The Indirect bid was disappointing, partially compensated for by a high hit ratio.
With regard to monetary policy, ECB president Trichet yesterday reaffirmed that current rates remain appropriate, as the incoming information confirmed their assessment of a gradual recovery and subdued inflationary pressures. As such, Trichet signalled that no change in policy should be expected anytime soon. At the same time, concerns are growing about the strength of the euro as well as the deterioration in public finances. This may put the ECB in awkward position next year, as the strength of the euro implies some downside risks to the outlook for the euro zone economy and a correspondingly more distant rise in interest rates, while the deterioration in government finances points strongly in the opposite direction. Yesterday, Trichet sent a notably tougher message on fiscal policy by indicating that ‘the need for ambitious and realistic fiscal exit and consolidation strategies is becoming increasingly pressing’. It remains however to be seen whether governments will have the vigour to scale back their budget deficits. Overall, we continue to believe that the ECB is unlikely to raise rates until the end of next summer at the earliest, which is in line with current market expectations. For a complete review of yesterday’s ECB press conference, we refer to our ECB flash.
Regarding today’s bond trading, the calendar doesn’t provide much guidance. As such, trading may be mainly driven by the technical picture, which is still bullish following last week’s break higher. Yesterday, bonds again tested the upside, but fell lower after the US 30-year bond auction. This may point to more sideways trading today, as the post-Payrolls highs may remain a hurdle too high for now and equities moved again higher in Asia this morning. Over the previous days, gains in the equity markets failed to push bonds much lower, which suggests that losses may remain limited.
Regarding US Treasury market, since the start of September, Treasuries were in a sideways range, digesting the gains eked out since the turnaround on June 10. Last week however, Treasuries broke through the top of this sideways range (118-16+ T-Note Future) in a convincing way, opening the way for more MT gains with 120-13+ (LT breakdown weekly cont. charts) and 121-16 (April 15 high) potential next targets. In the cash market, the 10- and 30-year yield levels fell below key support levels (3.25% for the 10-year and 4.15% for the 30-year) confirming the break in the future market. The 2- and 5-year yield on the contrary couldn’t make such a technical important step (0.85% and 2.16%respectively), which at least for the 2-year is not really a surprise, given that monetary policy shouldn’t be loosened any further. We didn’t expect the technical break at the longer end of the curve based on our fundamental view, notably our above consensus economic growth outlook and our expectation that while the accommodative Fed stance is a bond-supportive feature, it should be clear that the Fed is slowly coming closer to implementing its exit strategy. So, the MT bullish technical picture makes us think that more gains are possible, but given our fundamental view, we would build back long exposure at lower yield levels (3% for the 10-year looks not bad).
Regarding European bond market, following a period of sideways trading, the Bund broke higher too last week. The break above 121.74 was also confirmed in German 10-year yields (below 3.20%), which implies that the medium term technical picture has become bullish again. This brings the all-time highs in the Bund (126.53) and lows in yields (2.85%) again in the picture. Although the underlying sentiment is positive and more gains may occur, we remain cautious about the upside potential and wouldn’t install new long positions at current levels. Yesterday, the Bund reached the targets of a first double bottom formation with neckline at 120.84, which may mean upside may become more difficult.
In the UK, the PPI and trade balance are scheduled for release, but these shouldn’t have much impact on trading.
